Quest Diagnostics Incorporated (NYSE:DGX) Q2 2024 Earnings Call Transcript

Quest Diagnostics Incorporated (NYSE:DGX) Q2 2024 Earnings Call Transcript July 23, 2024

Quest Diagnostics Incorporated beats earnings expectations. Reported EPS is $2.35, expectations were $2.31.

Operator: Welcome to the Quest Diagnostics Second Quarter 2024 conference call. At the request of the company, this call is being recorded. The entire contents of the call, including the presentation and question and answer session that will follow, are the copyrighted property of Quest Diagnostics with all rights reserved. Any redistribution, retransmission or rebroadcast of this call in any form without the written consent of Quest Diagnostics is strictly prohibited. Now I’d like to introduce Shawn Bevec, Vice President of Investor Relations for Quest Diagnostics. Please go ahead, sir.

Shawn Bevec : Thank you, and good morning. I’m joined by Jim Davis, our Chairman, Chief Executive Officer and President; and Sam Samad, our Chief Financial Officer. During this call, we may make forward-looking statements and we’ll discuss non-GAAP measures. We provide a reconciliation of non-GAAP measures to comparable GAAP measures in the tables to our earnings press release. Actual results may differ materially from those projected. Risks and uncertainties that may affect Quest Diagnostics future results include, but are not limited to, those described in our most recent Annual Report on Form 10-K and subsequently filed reports on Form 10-Q and current reports on Form 8-K. For this call, references to reported EPS refer to reported diluted EPS and references to adjusted EPS refer to adjusted diluted EPS.

Any references to base business, testing, revenues, or volumes refer to the performance of our business excluding COVID-19 testing. Growth rates associated with our long-term outlook projections, including consolidated revenue growth, revenue growth from acquisitions, organic revenue growth, and adjusted earnings growth are compound annual growth rates. Finally, revenue growth rates from acquisitions will be measured against our base business. Now, here is Jim Davis.

Jim Davis: Thanks Shawn and good morning, everyone. We delivered another strong quarter, with base business revenue growth of nearly 4% and total revenue growth of 2.5% as well as continued improvement in productivity and profitability in the base business. This performance is due to growth of new physician and hospital customers, more favorable test mix that includes greater adoption of advanced diagnostics and continued strength in healthcare utilization. We also made progress improving our operational quality and efficiency through greater use of automation and AI. In addition, we are excited to announce four acquisitions that meet our criteria for growth, profitability and returns, and that will enable us to expand in strategic growth areas.

Our planned acquisition of LifeLabs, a trusted name in laboratory services for millions of Canadians, will enable us to grow in Canada, which has a population that is growing, and aging faster, than in the U.S. LifeLabs is especially strong in two of Canada’s largest and fastest growing provinces, British Columbia and Ontario, which collectively account for about half of the country’s population. We are familiar with the Canadian market, having delivered reference testing to many providers there for over 20 years. LifeLabs has been one of those reference partners for about a decade, so we know firsthand that their business, team and reputation is strong, and provides a solid foundation for growth. We expect to complete the transaction by the end of the year.

Our recently announced acquisition of Select Lab Assets of Allina Health, a leading non-profit health system, will enable us to extend our reach in Minneapolis and throughout Minnesota and Wisconsin. We also announced our plans to acquire the outreach lab assets of OhioHealth, a nationally recognized charitable health system in Ohio. Both transactions will broaden our presence in geographic areas of the United States where we’ve had limited access to providers due to the predominance of health systems. These acquisitions show our ability to attract and partner with top, growing health systems that share our commitment to expanding patient access to innovative and more affordable testing. We expect to complete both transactions in the third quarter.

We also completed our acquisition of PathAI Diagnostics, which provides a readymade platform on which to scale digital pathology and AI to help health systems and other providers improve quality, speed and efficiency in cancer diagnosis. These acquisitions take time and involve teams of dedicated individuals. I want to personally thank my Quest colleagues for delivering on our M&A strategy, and we will now turn our attention to the hard work of integrating these deals. Now, I’ll recap our strategy and discuss highlights from the second quarter. Then Sam will provide detail on our financial results and talk about our updated financial guidance for 2024. Our strategy to drive growth is focused on delivering solutions that meet the evolving needs of our core customers, physicians, hospitals and consumers.

We enable growth across our customer channels through advanced diagnostics, with an intense focus on faster growing clinical areas, including within brain health and molecular genomics and oncology. In addition, acquisitions are a key growth driver, with an emphasis on accretive outreach purchases as well as other independent labs. Our strategy also includes driving operational improvements across the business, with the strategic deployment of automation and AI to improve quality, service, efficiency, and the workforce experience. Here are some updates on progress we have made in each of these areas. While we grew total volumes from Diagnostic Information Services 1.1% with base business volume growth of 1.7%, volumes from our base clinical business grew 3.2% in the second quarter, due to the strength among physicians and hospitals.

In Physician lab services, we delivered another quarter of high single-digit base business revenue growth. This growth was driven by continued strength in healthcare utilization, as well as overall market growth, and share gains due to new customer wins. We drove favorable test mix as well as growth in test per requisition, which we attribute to greater utilization of our expanding portfolio of advanced diagnostics. Finally, we also saw strong volume and revenue growth within Medicare Advantage plans, where narrow network strategies direct testing to high quality, cost-efficient options like Quest. Our broad health plan access, which extends to approximately 90% of covered lives in the U.S., enabled us to take advantage of high demand for lab services, consistent with recent quarters.

Health plans value our ability to improve access, scale innovation and drive costs out of healthcare. We are also working to develop opportunities to serve new geographies with our health plan partners. In Hospital lab services, we grew base business revenues by nearly 4%. Growth of reference testing remains higher than historical levels as hospitals struggled to fill open positions, especially in technical fields, such as histotechnology, microbiology and cytotechnology. Our advanced diagnostics portfolio provides a compelling alternative for hospitals to send us more reference work. Hospitals face several challenges, including high supply costs, high wages and decisions about how and where to deploy their capital. Patients want better value from lab services as well as easier access.

Plus, diagnostic innovation is evolving at a fast pace. These dynamics are contributing to an accelerating trend of outreach acquisitions and professional lab service arrangements with the national labs. Our specialization and scale empower us to deliver a breadth of quality, innovative and accessible services that are often far more affordable for the patient. That’s why top hospitals are choosing Quest for reference testing, professional lab services and outreach asset sales that deliver quality and efficiency. In consumer-initiated testing, our consumer facing platform, questhealth.com, grew total revenues nearly 40% while base business revenues grew more than 50% versus the prior year. As we learn more about our customers as our portfolio expands, we are improving growth and marketing productivity.

Today, about 25% of our revenues are from existing customers and 20% of our revenues are from tests we introduced in the past year. In Advanced Diagnostics, several key clinical areas drove double-digit revenue growth, continuing the trend in recent quarters. This growth was particularly strong in brain health, women’s health, particularly prenatal and hereditary genetics, and advanced cardiometabolic health. Our Alzheimer’s disease portfolio was the primary driver of growth for our brain health offering. Demand was strong for our AD-Detect blood tests which assess risk based on amyloid, p-tau and APOE biomarkers. Demand was also strong for our CSF test options for aiding treatment decisions. Yesterday, we introduced our Neurofilament Light Chain test, which helps assess neuronal damage that may signify Alzheimer’s disease as well as multiple sclerosis and other neurodegenerative conditions.

In molecular genomics and oncology, we are encouraged by early results of our Haystack MRD Early Experience program prior to the broad national launch later this year. Physicians from leading cancer institutions are using the Haystack MRD blood test to assess cancer recurrence and treatment response for a range of cancers, including colorectal, lung and breast. We also grew the body of evidence on the clinical and economic value of ctDNA blood testing in cancer care. A study published in JAMA Health Forum in June found that MRD testing could reduce costs for health plans, particularly commercial payers, by identifying patients that would benefit from chemotherapy after stage II colon cancer surgery. In addition, research presented at the June ASCO conference showed that Haystack MRD testing identified complete clinical response to immunotherapy for patients with colorectal cancer earlier than standard assessments, such as PET,MRI and endoscopy scans.

Finally, we recently expanded our Haystack research collaborations to include Lisata Therapeutics, which will use Haystack MRD to study an investigational treatment for advanced pancreatic cancer. Turning to advanced cardiometabolic testing, we are seeing interest in several biomarkers that improve early detection of cardiovascular and metabolic diseases like diabetes and kidney disease. These include insulin resistance, which can identify pre-diabetes risk before AIc tests, and ApoB, a more precise marker of heart attack risk than traditional lipid panels. They also include Lp(a), which is an inherited marker of heart disease risk found in up to 20% of the population and for which several therapies are now in development. Turning to operational excellence, our Invigorate program aims to deliver a targeted 3% annual cost savings and productivity improvements.

During the quarter, we expanded our use of automation and AI in order to improve productivity as well as service levels and quality. For instance, we advanced our use of automation in front-end specimen processing to now include five of our labs, freeing more of our processors to focus on value-added work. We also expanded our AI capabilities in microbiology to include the ability to segregate out specimens with no evidence of microbial growth so our medical scientists can concentrate on reviewing those with the greatest likelihood of disease. In addition, we broadened our use of AI in customer service to help our representatives access answers more quickly, improving their efficiency and service quality. Now, I’ll turn it over to Sam to provide more details on our performance and our 2024 guidance.

Sam?

Sam Samad : Thanks, Jim. In the second quarter, consolidated revenues were $2.4 billion, up 2.5% versus the prior year while base business revenues grew 3.8%. Organic base business revenues grew by 3.1%. Revenues for Diagnostic Information Services were up 2.8% compared to the prior year reflecting strong growth in our base testing revenues partially offset by lower revenues from COVID-19 testing services. Total volume, measured by the number of requisitions, increased 1.1% versus the second quarter of 2023 with acquisitions contributing 40 basis points to total volume. Total base testing volumes grew 1.7% versus the prior year. Total revenue per requisition was up 1.6% versus the prior year, driven primarily by an increase in the number of tests per req and favorable test mix, partially offset by the timing of certain value-based arrangements in the second quarter of 2023 that did not repeat this year and lower COVID-19 testing.

Base business revenue per req was up 2.4%. Unit price reimbursement was flat. Clinical base business revenues were up 5.1% while volumes grew 3.2%. This primarily reflects growth through our physician and hospital channels, which comprise approximately 90% of our total revenues, and excludes the impact of lower volumes primarily in our employer businesses providing workforce drug testing and employee population health services. Reported operating income in the second quarter was $355 million, or 14.8% of revenues, compared to $348 million, or 14.9% of revenues last year. On an adjusted basis, operating income was $398 million, or 16.6% of revenues, compared to $389 million, or 16.7% of revenues last year. The increase in adjusted operating income was due to strong growth in the base business, partially offset by lower COVID-19 testing revenues and wage increases.

Reported EPS was $2.03 in the quarter compared to $2.05 a year ago. Adjusted EPS was $2.35, versus $2.30 the prior year. Cash from operations was $514 million year-to-date through the second quarter versus $538 million in the prior year. Turning now to our updated full year 2024 guidance. Revenues are expected to be between $9.5 billion and $9.58 billion. Reported EPS expected to be in a range of $7.57 to $7.77, and adjusted EPS to be in a range of $8.80 to $9.00. Cash from operations is expected to be approximately $1.3 billion, and capital expenditures are expected to be approximately $420 million. Given the uncertainty around when the LifeLabs acquisition will close, we are not including this transaction in our updated 2024 guidance. However, in the first 12 months after closing the acquisition, we expect the transaction to generate approximately $710 million in annual revenues and to be slightly dilutive to GAAP EPS, due primarily to amortization of intangibles and other items, but approximately $0.10 to $0.15 accretive to adjusted EPS.

These assumptions include the impact of expected debt financing to close the acquisition. With that said, the following are some key assumptions underlying our updated guidance for you to consider. The increase in our revenue guidance reflects the recently announced acquisitions of PathAI Diagnostics, Allina Health, and OhioHealth as well as the strength of our base business. The PathAI Diagnostics acquisition closed in June, while Allina Health and OhioHealth are expected to close in Q3. The revenue contribution from these acquisitions represents the majority of the increase in our updated revenue guidance. As a reminder, new acquisitions are typically breakeven to slightly profitable initially with profitability expanding over several quarters.

Therefore, we are not expecting a material contribution to earnings from these acquisitions in 2024, but do expect increasing profitability next year. No change to our expectation for dilution from Haystack Oncology of an incremental $0.20 to adjusted EPS for the full year. Operating margin to expand for the full year, driven by volume growth and improved productivity. Net interest expense expected to be approximately $190 million. This does not include interest expense related to debt financing for the LifeLabs acquisition. Weighted average share count to be flat compared to the end of 2023. Finally, our operations were affected by the worldwide IT outage last week, which limited our ability to collect and process specimens on Friday and through the weekend.

Our labs were processing specimens by Friday afternoon, and the rest of our operations, including patient service centers, were largely restored to normal by yesterday morning. At this point, we estimate the IT outage and a minor impact from hurricane Beryl in Texas earlier this month could amount to a roughly $0.06 to $0.08 headwind on our Q3 earnings. This is currently reflected in our updated full year guidance. With that, I will now turn it back to Jim.

Jim Davis : Thanks, Sam. To summarize, our business delivered strong total and base revenue growth across our core customer channels, due to strong commercial execution, innovative offerings and ongoing strength in healthcare utilization. We announced four acquisitions that meet our criteria for growth, profitability and returns and position us for growth in new geographic and service areas. We improved productivity as well as service levels and quality, through greater use of automation and AI. Finally, I’d like to personally thank my nearly 50,000 Quest colleagues for our strong performance this quarter, which is largely the result of the dedication, care and collaboration that they show patients, customers each and every single day.

This commitment was exemplified by the tireless efforts of our teams to restore outstanding service for patients and customers this past weekend following the global IT outage. I’m proud to work with so many talented people committed to living our purpose, working together to create a healthier world, one life at a time. With that, we’d be happy to take your questions. Operator.

Q&A Session

Operator: Thank you. We will now open it up to questions. [Operator Instructions]. The first question will come from Ann Hynes of Mizuho Securities. Your line is open.

Ann Hynes : Hi, good morning. I just had a follow-up question on volume. I believe you said the total base volume is up 1.7%. But if you exclude employer base, it’s up 3.2%. Can you just give us more detail on what’s happening in that business? Is it just the overall job market? And maybe if you can provide some like profitability versus staff position-based business versus the employer-based business and whether or not it was in line with your estimates? Then my second question just has to do around the Canadian acquisition. Can you just give us more details on that market? How is it different than the U.S.? Why you view it as attractive? Maybe some long-term growth revenue algorithms versus the U.S. business? Is it growing in line with the business? Is it higher growth? That would be great. Thank you.

Jim Davis: Yeah, good morning Ann. Let me start here. So, on the employer side, we have two principal businesses that serve employers. One is our Employee Drug Testing Business, second is our Employer Population Health business. There is a third business as you know called ExamOne that does health risk assessments for life insurance companies. Taken together, all three of those businesses showed meaningful declines in the quarter, and really largely represent the difference in the 3.2% that Sam referred too and the 1.7%. In the drug testing market, there’s a couple of shifts going on. Number one, a lot of the job growth is still coming in the services industry, hotel workers, restaurant workers. A lot of those industries just have given up on drug testing.

Other companies that still do drug testing, as you probably know, many have eliminated marijuana off the panel, so that has created some pressure. Then the final thing I’d tell you, is there’s a shift going on in employee drug testing, where more companies are doing what we call on-site or oral testing, and if that test is positive, it eventually reflexes back to a central lab. But if it’s a negative test, it’s just an on-site screen and the employee passes and we don’t get that work. On the Employee Population Health, we’re just seeing companies not spend as much money on these wellness events that they’ve typically done in the past. Finally again, ExamOne, our life insurance business, that does risk assessments for life insurance. Just the life insurance policies, we saw a spike.

During COVID people started to get life insurance again. Post-COVID, that negative trend has continued, which we were seeing actually pre-COVID. Now, let me turn to the Canada market for just a minute here. So look, there’s a lot to like about the Canadian market. First of all, a population of roughly 41 million people. The population growth rate is actually faster than the U.S. The population growth there at about 1.1%. Here in the U.S., population growing less than 50 basis points. The aging of the population there as well is a good trend that we like and LifeLabs is really centered in two key markets, British Columbia and Ontario; Ontario being the biggest province in Canada, British Columbia being the second largest province. Collectively, those two provinces are over 50% or close to 50% of the Canadian population.

We like the reimbursement model in Canada. It’s steady. It’s consistent. We think it will fill growth over the coming years. When we look at things like test per req, when we look at the types of testing done here in the U.S. versus Canada, we think there’s opportunity to grow the types of testing that we bring into that market from an esoteric standpoint, from an advanced testing standpoint. So we feel great about entering the Canadian market. By the way, it’s a market we know. We’ve served that market for many, many years as a reference provider. We’ve served LifeLabs, we’ve served other independent labs and hospital labs up in Canada. So we know the market, we’re familiar with it, and we think it’s a great opportunity for Quest Diagnostics.

Sam Samad: Maybe a couple of comments to add on the services businesses Ann, just to give you some financials behind them or at least some percentages. I mean, the Workforce Health Solutions businesses, Employer Population Health, and the Employer Solutions are less than 5% of our overall revenues. So just to give you a sense of bucketing of how much those businesses are. So they are not that material or not material to our overall revenues, but as Jim said, they have been impacted post-COVID somewhat significantly and with some of the market dynamics in the drug testing business, so they are impacting our growth rates. And then ExamOne is on top of that, but it’s also impacted by some of the dynamics that Jim said coming out of COVID. So these businesses are down significantly year-over-year, but we don’t expect further deterioration as we look forward. So there is a year-over-year impact, but we don’t expect that to further amplify as we go forward.

Shawn Bevec: Operator, next question.

Operator: Yes, the next question will come from Kevin Caliendo of UBS. Your line is open.

Kevin Caliendo: Thanks for taking my question. It’s not usually your want to raise guidance by more than a beat, in any particular quarter. Yet you did, and now we find out there was actually from what appears to be a core, even a greater upside in the second half than what you had originally had, if you back out the impact of the strike and the hurricanes and the like, the IT issues, I mean. So, is that mostly driven just by core? Are you expecting margins to expand a little bit on a year-over-year basis more than what we saw in the second quarter? I guess, I just want to understand what’s driving the enthusiasm for the second half improvements. You had the M&A stuff that you mentioned, but you said there wasn’t a lot of contributions. So I’m guessing its core, but I’m wondering, is it expected volume? Is it expected mix? Is it expected cost to come in better? You know wage, labor, churn, that kind of thing.

Sam Samad: Yeah, so maybe I’ll start Kevin, and Jim can add comments. First, let’s kind of talk about the details in terms of what we shared. We said we’re going to take up revenues by $100 million. We said we’re going to take up EPS – and this is at the midpoint. We’re going to take up EPS by $0.05 to $8.80 to $9. Within the $100 million that we talked about, the majority of that is really new M&A. So essentially M&A that we have signed, that we expect to close sometime between mid Q3 and the end of the year, and those reflect the M&A related to, or the transactions which are Allina Health, OhioHealth. We have some upside from PathAI as well, which we closed in Q2, but wasn’t in our original guidance. So the revenue has a majority – the majority of the revenues is really driven by the M&A that we expect to close.

The EPS increase is related to contribution from this M&A, although as we talked about in the prepared remarks, M&A ramps up in terms of profitability, so 2024, in the second half, very little contribution in terms of profitability from M&A. The remainder, I would say is contribution from the base business and some M&A, but little. And we are absorbing as you said, the impact of the IT outage, which is $0.06 to $0.08 in Q3 that we expect to, that we have now sized. This is preliminary. We’ll get better detail as we go, but we are absorbing that impact. So, in terms of what’s driving this improvement or the raise of EPS, we’re basically continuing with a lot of the productivity work and the cost reductions that we have talked about. We have a lot of the AI and productivity improvements that Jim mentioned, a lot of the focus on improving margins.

Importantly, base volumes continue to be very strong, and that’s the biggest, I would say driver in terms of improved margins in the business. We continue to see base volumes be strong, utilization be strong. So really, that’s the key driver. It’s strength of volumes. It’s continued productivity and cost improvements. It’s also the fact that we have, as we’ve talked about many times over previous calls, a positive pricing and reimbursement environment, which is now stabilized, which is now flat to improving, as opposed to a negative price impact that we used to see in prior years.

Jim Davis: Yeah. Kevin, you probably saw a meaningful improvement in rev per rack in the quarter, and as Sam mentioned, within that rev per rack calculation, price per task, flat to last year. So the improvement is really coming in three areas. One, test per req continued to be very strong, north of four. Pre-COVID, that was a number that was south of four, it was in the threes. So that’s a nice uptick, and that’s coming from some of our advanced testing around allergy, tick testing, cardiometabolic testing, the neurology testing. And in that also is a mixed improvement that comes from some of those advanced tests. The final thing I’d say is, we saw again, strength in our overall Medicare Advantage and Medicare Book of Business.

That pricing as you know, tends to be better than the average, and we also see more advanced tests coming on those requisitions versus our normal general health and wellness requisition. So we expect those trends to continue into the back half of the year, and that’s contributing to the improvements that we’re laying out there.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Michael Cherny of Leerink. Your line is open.

Michael Cherny : Good morning and thank you so much for taking the question. Maybe if I can just dive a little bit into the market. I know there’s still some small moving pieces. I appreciate the color you’ve given so far on some of the employer testing. If I sort through all of the data points you have, the $3.2 billion base business volumes, (A) I just want to make sure I got that number correctly. And then (B) as you think about that number, how do you think about that in terms of translating where you see the health of broad-based market utilization versus where your competitive position is allowing you to take share? I guess just trying to understand fully where you see utilization baked into the implied second half guidance versus what we’ve seen over the last six to 12 months on a baseline business. Thanks so much.

Jim Davis: Yeah, again, the 3.2% represents the volume growth that we see through what we call our core or base business. And that means our physician business, our hospital reference business, our hospital PLS business, and embedded in that is both clinical, as well as anatomical pathology. So that entire book of business, which is about 90% of the company, the volumes grew 3.2%. Down from Q1, but the compare in Q2 was higher. But again, the 3.2%, we feel really good about that. Now that 3.2% volume growth again translated into 5.1% revenue growth, and that was coming again on the strength of test mix plus the test per req increase that we’ve been seeing year-over-year. So we feel good about that, again, going into the second half of the year.

In terms of the implied growth in the second half of the year, it’s in the 3.7% revenue range. So again, and that’s just the base or organic, that’s without acquisition. The timing of the close of these acquisitions we’ve set in Q3 with Allina and OhioHealth, we just don’t know when in Q3, okay, so there’s still some uncertainty about when these deals will officially close.

A – Sam Samad: And Mike, good morning. Maybe I’ll add a couple of comments just in terms of utilization. I mean, as we have been mentioning, utilization continues to be strong. We’ve seen it strong in Q1. We’ve seen it strong in Q2. The year-over-year compare in Q2 was maybe a little bit tougher versus Q2 of 2023. We had some lapping of some wins, and just overall we saw more of a resurgence in the base business in Q2 of last year. But in terms of the dynamics there, we do believe that both in terms of – there’s strong utilization out there. We think some of it is return to care, but also just general strength of utilization by just additional testing, and that’s reflected in the higher number of tests per req that we’re seeing, but also we are gaining share. We do believe that we are gaining share, and we’re gaining share through some of these also outreach acquisitions that we’re doing that help us direct more testing to Quest.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Patrick Donnelly of Citi. Your line is open.

Patrick Donnelly: Thanks for the question guys. Sam, maybe just to expand on the utilization piece. Obviously, you guys have seen pretty nice elevated levels there the past couple of quarters. Can you just talk about what you are seeing and then what the guide implies in terms of how you’re feeling about it? I know previously, the guide just assumed normal utilization. Obviously, it stayed a little bit elevated here. And just how you are thinking about the trend? Does it gradually come down to normal? We’d love to just discuss that a bit. Thanks.

Sam Samad: Yeah, I mean, as we’ve talked about before Patrick, we do expect eventually utilization to level off to essentially what we’ve talked about in terms of our long-term growth algorithm, which is roughly around 3%-ish in terms of organic growth. And then as we said before, in terms of long-term growth, we expect 1% to 2% contribution from acquisitions. So we still think longer term, if you are thinking over the next, let’s say, longer period. I’m not going to necessarily bracket it with a time period, but I think that’s the right algorithm to be thinking about. In terms of for us, our current guide, right now at the midpoint we’re saying total growth is close to 3%, 3.1%. Our base revenue guide is somewhere around 5% for the full year.

Our second half, if you think about second half, that’s essentially on the base revenue growth. It’s about a 5.3% second half growth. Now recall the 5.3% in the second half, and this is revenue. It includes as we said, the majority of the $100 million take up of the guide is acquisitions. So in that 5.3% second half, there is a significant portion which is acquisitions. So in effect, if you look at just organic as Jim just alluded to, it’s actually a slightly slower second half than what we saw in the first half. So embedded in that is the expectation Patrick, that this utilization doesn’t continue at the same level, but starts to slow down a bit. So again, total growth, first half base – or sorry, full year base is 5%, second half base is 5.3%, but within that there’s some acquisition, so the second half is closer to something between 3.5% to 4% in terms of base.

Shawn Bevec: Operator, next question.

Operator: The next question comes from David Westenberg of Piper Sandler. Your line is open.

David Westenberg : Hi Noah. Thank you for taking the question. I just wanted to take it a little bit more of a long-term and look at the business here. How should we think about digital pathology, in light of the acquisition with PathAI? Can we see a more immediate path to incorporate it more broadly? If so, would there be cost savings in the intermediate term? And then, is there any maybe potential for pricing benefits given that a human plus AI kind of reading probably is a better outcome and so maybe would justify kind of a higher price and just as a background. Can you talk about maybe a broader framework for how much revenue of your business is pathology overall? Just anything you feel comfortable with. Thank you.

Jim Davis: Yeah, we said in the past, just on our revenue from anatomical pathology, that it was – and this was pre-PathAI diagnostics, said it was roughly a $500 million book of business. But we’re excited about the digital pathology opportunity on numerous fronts. On the surface, unlike radiology, digital pathology does not naturally lower your cost, because you’re actually, you still need to create the slide. Once you’ve created the slide, then you digitize the slide, okay, so there’s actually an extra step in the process. Now here is where it creates productivity and as you said, we think better quality. Number one, we do anatomical pathology in over 20 locations across the country, because you want the pathologist to sit right near where you are preparing the slide, so that you don’t have to move slides and vehicles and things like that.

So we believe that it’s going to – digital pathology will allow us to collapse the network of sites that actually do what we call the histology work or the preparation of the slides. So there will be cost savings when we collapse that network. Second is, it allows us to route the image to expert pathologists wherever they sit in the country. So if our guru for breast pathology sits on the west coast, you move those slides out there. If the prostate guru sits on the east coast, you move those slides there. So, and yes, we believe once you’ve digitized that slide, there’s many companies out there that are working on algorithms. There’s one or two that have been FDA approved that allow you to apply algorithmic analysis to the digital image in order to improve the quality of the read.

In terms of reimbursement, we absolutely believe there’s a strong case to be made for a higher reimbursement using these algorithms. The final thing I would tell you is that, with digital pathology, it opens up a realm of new just histology-only types of operations. Meaning, we will take on the histology work for a health system. They’ll still keep the pathologists, but they’ll shut down their histology operations. We’ll do the slide preparation, digitize it, and send that back to the hospital pathologist for them still to do the reading. We call this a technical-only solution, and it’s a solution that’s starting to take off and the margins on the technical component of histology are quite good. So we’re bullish on the overall market opportunity here.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Erin Wright of Morgan Stanley. Your line is open.

Erin Wright : Great. Thank you for taking my questions. I have a two-parter here. On value-based care contracts, you mentioned that you lacked some of the payments that were made through those contracts or relationships last year. I guess how much did that benefit you last year and how should we be thinking about modeling that on a quarter-to-quarter basis? Will those incentive payments or contributions, are they relatively one-time in nature? Is that something you’ll be breaking out for us going forward and how material have those payments been, I guess, year-to-date? And then a second part of my question would just be more on the regulatory environment. Just what you are thinking in terms of PAMA and SALSA and your expectations into 2025 on that front? Thanks.

Jim Davis: All right, so let me start with your value-based care comment. I’ll ask Sam to add some color, and then I’ll come back and address PAMA and SALSA. So, on the value-based care, it made positive contributions in the second quarter of this year. They just weren’t bigger than the second quarter of last year. Last year we had a meaningful gain. We acknowledged that last second quarter. Again, this year it was positive, but the delta between last year and this year was a headwind for us. It is very difficult for us to give you guidance on how to model these things. There’s really two principal components to these value-based payments. One is from shared savings from acquisitions, and those are lumpy. They are based on the acquisitions they do.

And in some cases, payments can be six months post-deal closure. In some cases it could be a year post-deal closure. It just depends on the contract. The other type of value-based incentive payment that we have with some of our payers is around the movement of requisitions from high-priced, either out-of-network laboratories or high-priced health system laboratories. And again, that could be a once-a-year true-up, and depending on when we sign that contract, it could be in June, it could be in January, it could be in April, so very, very hard to model these things. So Sam, any other color on this.

A – Sam Samad: I think you’ve really captured it, Jim. The key thing there Erin is, it’s difficult to give you a sense as to how the pacing is going to be. We’ve always said these are lumpy and sometimes there’s also accounting nuances on these, where if it’s a shared service, shared savings commitment for instance, we might accrue for that shared savings as if we’re not going to achieve it, but then when we do achieve it, we have to release that accrual so to speak, and get a benefit in that quarter. Suffice it to say that these continue to be a positive for us in terms of our overall pricing in Q2 of 2024. It was a pricing or a positive benefit for us in the quarter, but on a year-over-year base, we had a significant benefit in Q2, 2023.

So it impacted us negatively in terms of total revenues on a year-over-year basis. So I think everything that Jim said stands in terms of the difficulty of giving you a modeling algorithm for these. And then PAMA, Jim, did you want to comment?

Jim Davis: Yeah, in terms of PAMA in SALSA, while we continue to, we and our trade association and other independent labs continue to push the case for SALSA, we acknowledge it’s going to be difficult to get that through in a year with an election year, especially now given many of the changes that occurred in the last week. Having said that, we will continue to push very hard for another one-year delay in PAMA. The recent CBO scoring on this was actually bigger than it was last year. They projected it would save the government over $3 billion. And in addition, the committee in the House that overlooks this is looking for a pay for program to pay for continued telehealth benefits. So this becomes a really nice pay for program that can satisfy the requirement to fund the telehealth.

So we’re confident that at a minimum that would be a one-year delay in PAMA, and hopefully we can get this done and figure it out in the October-November timeframe as opposed to waiting for the December timeframe like we’ve seen in the past.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Brian Tanquilut of Jeffries. Your line is open, sir.

Brian Tanquilut : Hey, good morning guys, and congrats on the quarter. Maybe Sam, as I think about your comments on Haystack, I understand maintaining the drag guidance for this year. But how are you thinking about the ramp on that as we think about 2025 and given some of the announcements you’ve made on new partnerships there? So just curious how we should be thinking about the development and the ramp of Haystack going forward? Thanks.

A – Jim Davis: Yeah, sure. Good morning, Brian. So as we said in the prepared remarks, Haystack dilution this year will be somewhere in the $0.35 to $0.40 range, which is about a $0.20 increase in terms of dilution from prior year. For 2025 Brian, the way we see it is, it’s still going to be dilutive, but it’s going to be less dilutive than we see in 2024, because we will start to recognize revenues on the assay as we launch later this year. In 2026, we expect this – we expect Haystack to be slightly accretive. And we expect by the end of 2025 also to get to a positive return on invested capital from this acquisition. In terms of all the things that we’ve seen, the early launch has been really successful. We’ve had a very, very high interest in terms of number of key thought leaders and cancer centers that have signed up for this.

So everything that we see today is really encouraging. And you touched on the partnerships that we’ve made as well. We continue to sign new partnerships in terms of cancer centers that are, or companies that are partnering with us to evaluate the use of the assay and MRD in a specific type of cancer. So really excited about the upcoming launch. I think the early launch has been very positive, and hopefully this gives you a sense as to the, you know the financial impact in terms of accretion dilution.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Lisa Gill of JP Morgan. Your line is open.

Lisa Gill : Thanks very much and good morning. Since you last reported the LDT rule that came out, can you maybe just talk about what the impact is there? I heard your comments on PAMA and SALSA, but anything else on the regulatory front that we should be aware of?

Jim Davis: Yeah, thanks Lisa. So as you know, our trade association filed a lawsuit in the Federal Court of Texas, District Court of Texas, and work by outside counsel that the trade association has retained. It continues – we expect movement in the case in the latter part of this year, November, December, and probably into January of next year. Having said that, the rule is in place. We are running the company and operating the company with the rule in place. There’s certain requirements that we need to have in place by May of next year, including a complaint handling unit up and running, as well as the ability to report adverse events. And these capabilities, some of which we had in the company, some of which we have to add are ongoing as we speak.

We continue, we’ve launched training for the organization, in particular our R&D teams, our product marketing teams around design controls. And again, we’re living with the rule and implementing things for the directive of the FDA. We’ve said this year, it’s not going to add a material cost into the business, but we continue to evaluate what we need to be fully compliant, especially if the lawsuit is not successful.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Michael Ryskin of Bank of America.

Michael Ryskin : Hey. Thanks for taking the question guys. I’m going to stay on the regulatory side. It’s still fairly recent, but we had a couple of questions coming from investors on Chevron deference, and the Supreme Court ruling to overturn the Chevron to outshine what could mean for deregulation. It’s still kind of a hypothetical I think, but just curious what’s your take on that, given your place in the industry.

Jim Davis: Well, it certainly doesn’t hurt the case that we believe is in front of, again, the Federal District Court in Texas. I’m not a legal expert by any means, but as you know, look, Congress is the one that sets the operating parameters for various departments that exist like the FDA. We believe what Congress authorized the FDA to do, is to regulate medical devices. Congress also authorized the CLIA Act of 1988 that talked about the regulation of clinical laboratories. So we believe it’s very clear what Congress intended. Obviously, others don’t see it that way, but we do believe that yes, what has come out of the Supreme Court recently is favorable and clearly dictates what should occur within the four walls of regulatory bodies.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Jack Meehan of Nephron Research. Your line is open, sir.

Jack Meehan : Thank you. Good morning. Either for Sam or for Jim, I was wondering if you could give an update on what you’re seeing in terms of cost trends, how are wage costs trending, an update on turnover. And sorry if I missed this Sam, what’s the full year margin target? Thank you.

Jim Davis: Yeah, so from a wage standpoint, we said at the beginning of the year that we expected wage increases to be in that 3% to 4% range. We’re still operating within that 3% to 4%, so we’re comfortable with that estimate for the back half of the year that it’ll play out in that range. In terms of turnover, last year all-in for our frontline physicians, patient services, logistics, specimen processing, our laboratory workers, we were north of 20%. In the first quarter we came down below 20% into the mid-18s, and we kind of hung there in the second quarter. So we feel good that generally you can see an uptick sometimes after your first quarter, after bonus payments and things like that, but we’ve maintained a relatively flat position.

We obviously have some hot spots around the country in certain job categories that tend to be competitive-related, either with health systems or with other industries. So we address those hot spots and we expect to make meaningful improvements in the back half of this year.

Sam Samad: Yeah, and for a margin target Jack, we didn’t give one, so you didn’t miss it. But we did say that operating margins are expected to be up year-over-year, which is what we had shared also on the Q1 call.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Andrew Brackmann of William Blair.

Andrew Brackmann : Hi, guys. Good morning. Thanks for taking the questions. Sam, maybe one for you, just on the balance sheet and the upcoming debt maturities. Anything that you can sort of share in terms of your expectations for timing or interest costs associated with those refinancing? And I guess just related to that, any color that you can provide on the debt assumptions for the LifeLabs acquisition. Thanks.

Sam Samad: Sure, Andrew, and good morning. So, let’s start with the LifeLabs. What we are assuming, I mean, I shared in the prepared remarks that we expect the acquisition. First of all, we’re not expecting LifeLabs to close this year, at least in our guidance assumptions. It could, but we’re not assuming it’s in guidance. But for 2025 it’s a $0.10 to $0.15 EPS accretion, or at least in its first year, let’s call it that. It’s $0.10 to $0.15. We’re assuming that it’s funded by a combination of debt and cash. But within that assumption of $0.10 to $1.15 is that 75% of that purchase price is funded with debt. So the roughly $1 billion purchase price, 75% of it is debt funded, which is what drives the $0.10 to $0.15 accretion in the first year.

In terms of just broadly on debt assumptions and liquidity, etcetera, I think here you talked about balance sheet assumptions. Listen, a lot of that is going to depend on market conditions and depend on the timing of the close of some of these acquisitions, not just LifeLabs, primarily LifeLabs, but also we have OhioHealth, Allina Health. We also closed PathAI in June. So as we’ve been talking about, we’ve had a busy M&A pipeline and it’s starting to come to fruition. So we’re going to evaluate market conditions. We’ve got the flexibility to access the capital markets. We’ve got very strong short term liquidity through the access to our facilities. But our goal continues to be to target a 2.5x to 3x leverage ratio, that’s our goal. There could be some slight tip above that higher end of 3x, but then we expect to de-lever back to somewhere within that 2.5x to 3x in short time, given the growth and the accretion from these acquisitions.

So again, no specific debt number right now, but we’ll keep you posted as we get more timing on the closes of these acquisitions.

Shawn Bevec: Operator, next question.

Operator: The next question comes from Pito Chickering of Deutsche Bank. Your line is open, sir.

Pito Chickering: Good morning, guys. Thanks for fitting me in. A multi-part question here. How are volumes looking at from your preferred network customers versus everyone else? Looking at both the physician market and the hospital market, are you losing, gaining, or maintaining share? Any quantification of any of those would be helpful?

Jim Davis: Okay. So, on volume from our payers with preferred arrangements. The volume with several and of them Patrick, is higher. Now, some of that can be also driven by Medicare Advantage, the various size of the Medicare Advantage books of business. But in general, when we operate within these preferred networks where we have incentives in place to move, share from out-of-network labs, high-priced health systems, we definitely see benefits. In terms of market share statistics around our physician book of business and our health system book of business, it’s hard to tell, right. There’s just not great industry reports that talk about that. But I can tell you, when we said that that book of business was up 5.1% from a revenue standpoint, our physician growing faster than that, health system growing slightly lower than that, but still they are growing in ranges that are significantly above what we saw from a pre-COVID standpoint.

So that leads us to believe, and also just based on the number of new wins with large physician groups, the number of new wins in our reference book of business, it leads us to believe that, yes, we are picking up share in this industry. Much of that share, we believe, is coming from health systems that potentially aren’t as aggressive on some of that outreach book of business, from specialty labs and also from small, very small little regional labs.

Shawn Bevec : Operator, next question.

Operator: We have time for one last question, and that is from Stephanie Davis of Barclays. Your line is open.

Stephanie Davis : Hi guys. Congrats on the quarter, and thank you for fitting me in. I was just curious if there’s anything that’s changed either the environment or maybe in strategy that had this pick up in M&A so much this year. And how sustainable is this or how much of this is to kind of strike them while the iron is hot? Thank you.

Jim Davis: Yeah, no change in the strategy at all Stephanie. And as we’ve been saying for many quarters in a row, the M&A funnel is full. Now, we don’t go into a year planning on getting four deals announced in one quarter. It just, in fact, you would prefer to space these out a little bit, but there’s always somebody on the other end that you are negotiating with, and these things sometimes take time. So, look, we’re really excited about all of these. Allina Health in Minneapolis, it represents a market where the independent labs basically have really, really low share in that market space, so really excited about the Minneapolis marketplace. We’re also very excited about Columbus, Ohio, dominated by two health systems, very difficult for independent labs to operate there, and so this gives us a substantial foothold within that Columbus marketplace.

Obviously excited about the Canadian marketplace as we talked, and again, PathAI represents both, a nice opportunity in the Memphis marketplace itself, where we believe we can grow our book of business there. As well, it doesn’t really matter where that lab is located, because a lot of the work is done digitally, so it accepts specimens from all over the country. I would tell you that there’s still opportunities within the funnel. The emphasis continues to be on these outreach tuck-in deals. It continues to be in, to focus in markets where our share position or access to independent labs is waning, and that’s where our focus will be in the second half of this year.

Sam Samad: One other thing I’d add, Stephanie, is all of these acquisitions that we announced meet our criteria. They basically hit the mark on all of the criteria that we have. Accretive in the first year, they meet our return on invested capital threshold. They meet our MPV criteria. So again, the activity would depend also that these acquisitions are going to hit our profitability criteria and our heroic hurdle rate, and they do.

Jim Davis: Okay, so that concludes our call today. We really appreciate everybody joining. Thanks for your support, and have a great week ahead.

Operator: Thank you for participating in the Quest Diagnostics second quarter 2024 conference call. A transcript of prepared remarks on this call will be posted later today on Quest Diagnostics’ website at www.QuestDiagnostics.com. A replay of the call may be accessed online at www.QuestDiagnostics.com/investor or by phone at 866-363-1805 for domestic callers, or 203-369-0193 for international callers. Telephone replays will be available from approximately 10.30 a.m. Eastern Time on July 23, 2024 until midnight Eastern Time, August 6, 2024. Thank you for your participation, and you may disconnect.